Q3 : Now suppose the government (NOT the CB) wants to stabilise the shock in the...

Q3 :

Now suppose the government (NOT the CB) wants to stabilise the shock in the short-run. Explain whether it should increase the government deficit (∆G > ∆T ) or reduce it (∆G < ∆T ), and how it works.

Q4 :

Now suppose the government doesn’t do anything, and the CB wants to stabilise the shock. If the CB wants to bring output Y back to its long-run equilibrium level, explain whether it should decrease or increase the money supply M. What happens to the real interest rate in the short-run, if the CB follows this policy?

Q5 :

Suppose the CB wants to change the monetary base, B, to change M in the desired direction you answered in Question 4 above. Give one example—besides printing more cash or destroying cash—of how the CB would achieve its goal. Explain how your example works.

Q6 :

Continue to suppose the government doesn’t do anything, and the CB wants to stabilise the shock—but instead of output, the CB wants to bring the nominal interest rate i back to its long-run equilibrium level. Explain whether it should decrease or increase the money supply M, and what happens to short-run output Y if this policy is followed.

Expert Solution

Q3.

here I have taken the example of demand shock which can be negative and positive. negative demand shock means a sudden decrease in aggregate demand of the economy which leads to a recessionary gap in short-run. whereas positive demand shock means a sudden increase in aggregate demand which leads to inflation in the short-run.

Rahul Sunny answered 2 years ago

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